Chapter 2

lesson 3

Theory of Demand and Supply

 Indifference Curve Analysis
Scale of Preference:
Customer prefers different products and he may have a
different alternatives. All the list of alternatives (television,
camera, micro woven, computer) are called scale of
preference. How a consumer makes his desire and build up
a scale of preference. It influence by the following:
i) Magic money: money spend by the people differently
ii) Taste of the people: taste differ from man to man
iii) Income: increasing income influence preference
iv) External factors: social, culture, values, legal
v) Internal factors: perception, emotion, feeling, attitude
vi) Life cycle: different stages have different demand
v) Marketing program: influence on preferences
 Indifference Curve

Indifference Curves: represents satisfaction of a

consumer from two commodities. For all possible points on
an indifference curve, that the total satisfaction remains the
same .

An indifferent curve shows a set of combination of quantities of

two things having the same utility from each combination so
that an individual is indifferent between any combination.
 Indifference Curve

Combinations Apples Mangoes

• 01 15 01
• 02 11 02
• 03 08 03
• 04 06 04
• 05 05 05
i) Total satisfaction is the same in all these combinations.
ii) This is indifference schedule
iii) Transfer this schedule into diagram and thus get an
indifference curve (IC) in the following figure.
YA
Y
15 a

11 b
8 c
6 d e
5 IC
ICii
ICi
XM 0 IC
0 X
1 2 3 4 5

IC Curve Indifference Map

 Indifference Map

• Indifference Map is the graphical

representation of two or more indifference
curves showing the several combinations
of different quantities of commodities,
which consumer consumes,
 Properties of Indifference Curve
1) Indifference curves slope downward to the right:
horizontal, vertical and upward indifference curves do
not maintain the rules of indifference curves.
2) Indifference curves are convex to the origin: for the
effect of marginal rate of substitution of the two products.
3) Indifference curves can not intersect each other: if
it is intersecting then it will not IC because ICii will be
grater than ICi.
4) Higher IC represents a higher level of satisfaction:
and lower IC represents a lower level of satisfaction.
5) Indifference curves have no zero point: because each
point indicates the combination of two products.
Supply Analysis
Supply: the amount of a good that would be offered for sale at all
possible given price at any one instant of time.
Stock: is total volume of a commodity which can be brought into
the market for sale at a short notice.
i) Stock is the total volume: supply is a part of a stock
ii) For perishable goods supply and stock are almost same
iii) Durable goods stock-supply can be held back
iv) Low price and low supply but high stock
v) Stock is potential supply
Law of Supply: supply has functional relationship with price. As
the price of commodity rises it’s supply is extended, and as the
price falls it’s supply is contracted.
Supply Schedule: represent the relationship between the price
and commodities that people are willing to sell and produce.
 Supply Curve
Supply Schedule
Y S
Price Qua.
20 600 20 f
18 500 18 e
16 400 16 d
14 300 14 c
12 200 12
10 b
100
10 a

O 1 2 3 4 5 6 X
Figure:1
Quantity (00)
 Exceptions to the Law of Supply

i) Fixed items: this is not applicable for fixed items; land

ii) Labor factor: this factor is uncontrollable
iii) Limited resource: is exception of law of supply
 Shift of Supply Curve:

Price changes factor;

i) Extension: price increase and supply increases
ii) Contraction: price reduce and supply decreases
Price constant factor;
i) Increase: price constant but supply increase
ii) Decrease: price constant but supply decrease
 Shift in Supply
Figure-2: price change factor
Figure-3: price constant factor
OY = Price OX = Quantity

Y Y S Figure-3
Figure-2
S
Price
S A Ai
3

2 Si
Sii
1
S
O X O X
1 2 3 B Bi
 Supply Elasticity

Supply elasticity is a measure of the change to which the

quantity supplied responds to price change.
Elastic vs. In-elastic supply
i) Elastic supply: small change of price leads to great change in
supply.
ii) In- elastic supply: big change of price leads to small change
in supply. Perishable goods are in-elastic.
Elastic Supply In- elastic Supply

Y Y S

Pi S Pi
P
S

P
S
O X O X
08 20 5 7
 Causes of Changes in Supply
1.Price change: When the price of a commodity
increases, its supply increases and when the price
decreases, the supply increases you get
2.Change in producer's demand for consumption: If
a producer continues to consume more of his produce,
his supply will decrease. On the other hand, if he
reduces the consumption of his own goods then the
supply of the product will increase.
 Causes of Changes in Supply
(3) Change in cost of production: Increase or decrease in cost of
production also results in change in supply. If the cost of a good
increases, its supply will decrease. Again, if the production cost
decreases, the supply of the product will increase.

(4) Effect of Weather: In the case of some goods, the supply

may decrease or increase due to the effect of weathers For
example, timely rainfall and favorable weather will increase the
supply of agricultural produce.
Again if there is no timely rain or, if the weather is not favorable,
the supply of agricultural produce is normal will decrease.
 Causes of Changes in Supply
5) Change in the price of substitute goods: If the price of substitute
goods is low, the supply of that product will increase. This is because,
as the price of substitute goods decreases, sellers will not produce
more of those goods. In this case, the supply of the product will
increase. Similarly, if the price of a product's substitute increases, the
supply of that product decreases.

(6) Co-production : Sometimes two or more commodities are co-

produced, viz.- cotton and cottonseed. If the supply of one of these
goods increases, the supply of the other will naturally increase. For
example, if the supply of cotton increases, the supply of cotton seeds
will also increase. All these different reasons change the supply of any
product.